By Tom Westbrook
SINGAPORE (Reuters) - Investors are cutting the yen adrift, cooling on the idea that a big rally is just around the corner even as bets firm that a policy shift in Japan could come as soon as next week.
Little by little, the view that the Japanese currency was the cleanest wager against the dollar - destined to zoom as Japan hiked interest rates while the Federal Reserve cut - has faded as the dollar's stubborn strength has dominated trade.
One result is an uneasy calm in spot and options markets for dollar/yen as traders give up waiting for the yen to bounce.
Another is a dulling of the yen's allure as both a funding currency and a haven, since the risk of intervention on one hand and a policy shift on the other have left the yen in stasis.
"Earlier in the year everyone thought dollar/yen was heading to 120," said Patrick Law, head of Asia-Pacific FX trading at Bank of America in Hong Kong. "But now, very few people would expect it to go down that much."
Driven weaker by the widening gap between U.S. and Japanese interest rates, the yen has lost 13% on the dollar this year and at 150 is near the three-decade low of 151.94 that prompted government intervention a year ago.
A real effective exchange rate index value of 72.4 for the yen in September is the lowest since the Bank of International Settlements' records began in 1994 and lower than any of the Bank of Japan's retrospective projections, which date to 1970.
Yet even after the Bank of Japan took a step toward policy normalisation in July and loosened limits on bond yields, the yen fell - putting question marks over prospects for a sustainable rally built on higher Japanese interest rates.
Options pricing illustrates a market unprepared for - or unwilling to bet on - any dramatic rebound happening soon.
One-week implied volatility has spiked in advance of an Oct. 31 central bank meeting. However at most other tenors it touched 18-month lows in October and skew, which can measure directional bets, shows a steady decline in the relative popularity of dollar/yen puts over the year to date.
Market participants say what's changed is the expectation that Japan would be in the driver's seat for the yen this year.
"Even if the BOJ moves, you know, it's so powerless," said Masafumi Yamamoto, chief currency strategist at Mizuho Securities in Tokyo
"It's much smaller than the fluctuation of the U.S. yields," he said. "Dollar/yen is a function of U.S.-Japan yield gap and the U.S.-Japan yield gap is a function of the U.S. economy."